In In re Tyson Foods, C.A. No. 1106-CC (Del. Ch. Aug. 15, 2007), Chancellor Chandler held that granting “spring-loaded” stock options to key directors and executives without full disclosure of the practice is a breach of the directors’ fiduciary duties. In rejecting defendants’ motion for judgment on the pleadings dismissing the consolidated class action and derivative complaints, Chandler stated that the defendants failed to rebut the pleading stage inference that they “intended to conceal a pattern of unfairly stocking up insiders’ larders” with option grants right before the announcement of events likely to increase the company’s stock price. This decision would seem to support the notion, often dismissed by commentators, that the practice of granting “spring-loaded” stock options is improper per se, particularly in the absence of detailed disclosures.

Plaintiffs challenged three option grants issued by the company between 2001 and 2003. Each grant was awarded by Tyson’s compensation committee according to the company’s Stock Incentive Plan approved by shareholders. The plan permitted the compensation committee the right to distribute “incentive stock options” at a fixed price or “nonqualified stock options” which the committee could make exercisable at any price. Chandler inferred that the company’s proxy statements affirmatively described the challenged option grants as nonqualified stock options.

According to the facts alleged in the complaint, defendants suspected that the company’s share price would climb once the market learned of favorable company news, and using this knowledge, the company granted nonqualified stock options to select employees, guaranteeing that the options would shortly be in the money. Accepting the pleaded facts as true, the court held that when the option grants were finally revealed to stockholders, in appeared that defendants “did not straightforwardly describe such strike-price prestidigitation.” Instead, the court inferred that the company provided only minimal assurances that the options rested within the limits of the Incentive Plan. Chancellor Chandler framed defendants’ argument as contending that “a scheme that relies upon bare formalism concealed by a poverty of communication somehow sits within the scope of reasonable, good faith business judgment.”

The court rejected defendants’ argument that misleading or deficient proxy disclosures cannot form the basis of a derivative claim challenging the grant of the options and that the proxy disclosures were “temporally and analytically distinct from the option grants themselves.” The Chancellor stated that “[p]roxy statements that display an uncanny parsimony with the truth are not ‘analytically distinct’ from a series of improbably fortuitous stock option grants, but rather raise an inference that directors engaged in later dissembling to hide earlier subterfuge.”

The Chancellor explained that his opinion was consistent with possible scenarios proffered by Vice Chancellor Strine in Desimone v. Barrows, 924 A.2d 908 (Del. Ch. 2007). In that opinion, “Vice Chancellor Strine imagines a circumstance in which a COO and CFO of a corporation involved in a merger of equals have ‘missed their summer vacations, their children’s baseball games, and every important family occasion for four months’” due to their work on the merger. “In recognition of this sacrifice, a hypothetical compensation committee awards each officer a grant of stock options in advance of the merger announcement, knowing that those options will almost immediately increase in value and, indeed, insist that the options may be immediately exercised in the event of the forthcoming merger.” Chancellor Chandler stated that Strine’s hypotheticals assumed that the board has revealed their strategy to shareholders in complete and utter candor, and that in the case before him, the Tyson directors had failed to meet this crucial obligation.

The Chancellor noted that boards owe shareholders “duties of unremitting loyalty” and that “[d]irectors should not take a seat at the board table prepared to offer only conditional loyalty, tolerable good faith, reasonable disinterest or formalistic candor.” Armed with these standards, the court severely admonished the board for acting with “disloyalty that could not have arisen from a good faith business judgment.”

The Chancellor ultimately held that where the court may reasonably infer that a board of directors later concealed the nature of a grant of stock options, the court may further conclude that those options were not granted consistent with a fiduciary’s duty of loyalty.